Report into Misconduct in the Banking, superannuation and Financial Services Industry

The Final Report of the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Hayne Commission) was released on 4 February 20191. It is the culmination of more than 12 months of intensive scrutiny and analysis of the conduct and culture of Australia’s financial services sector.

The Hayne Commission focussed on the life insurance and general insurance industries (not marine or health), alongside banking, financial advice and superannuation sectors. This focus was consistent with complaints made to the Hayne Commission and material provided by the Australian Securities and Investments Commission (ASIC) and the Financial Services Ombudsman, as well as with the misconduct and conduct falling below community expectation disclosed by insurer responses to the Hayne Commission’s inquiries.

The Hayne Commission has already had an impact in New Zealand, being the trigger for the FMA and RBNZ report on life insurer conduct and culture released on 29 January 2019 (the Life Insurer Report). That is discussed in a separate article in this issue of Cover to Cover.

In this article, we look specifically at the findings of the Hayne Commission in the Final Report with regard to life and general insurance and consider how those findings may be relevant to the New Zealand insurance industry.

We conclude with a brief round-up of other over-arching themes in the Final Report that will have broad application across all financial services in Australia and, given the attention that is being paid to the Hayne Commission by the New Zealand regulators and government, in New Zealand as well.

Immediate Government Response

The Australian Government has already indicated that it will take action on all 76 recommendations in the Final Report.

The NZ Government has indicated that it will look closely at the Hayne Commission’s recommendations to consider whether they should be implemented here in New Zealand.2 The Ministers of Finance, Commerce and Consumer Affairs had already announced, following the release of the Life Insurance Report, that a consultation paper on proposed legislative changes to address regulatory gaps identified by the regulators would be released by May with legislation to be introduced later in 2019.3

The Ministers advised that they want to see:

Clearer duties on insurers and banks to consider a customer’s interests and outcomes, and to treat customers fairly.

An appropriately resourced regulator to monitor the conduct of insurance companies and banks, with strong penalties for breaching duties.

Changes applied to both insurance and banking, since the issues identified in both are similar, and there are industry overlaps.

In relation to financial advice in relation to life insurance, the Financial Services Legislation Bill (FSLAB) which is still before Parliament and the regulations yet to be made under it present other avenues for change. However, only minor changes are likely at this late stage, as the Government does not want to delay FSLAB coming into force before the next election due in late 2020.

Hayne Commission Insurance specific recommendations:

“Hawking” of insurance products:

The Hayne Commission recommends that “hawking” (unsolicited selling) of insurance products be banned.

It remains to be seen whether a similar ban will be imposed in New Zealand, but our view is that is unlikely – the use of uninvited selling techniques was not identified by the FMA and RBNZ as a significant issue in the New Zealand life insurance market and there are already a range of protections under the Fair Trading Act 1986 for consumers in relation to uninvited direct sales. These require insurers or brokers engaging in uninvited direct sales to give the customer a copy of the sales agreement (policy) with a clear description of what is being purchased and a summary of the customer’s right to cancel within 5 working days and receive a full refund.

Looking to the future, however, if insurance conduct is brought within the remit of the FMA and insurance products are included in the definition of financial products under the Financial Markets Conduct Act 2013 (FMCA), the additional protections set out in the FMCA in relation to unsolicited offers of financial products would then apply.

Funeral expense insurance policies:

The Hayne Commission recommends that funeral expense insurance policies should be included in the definition of a financial product, bringing it under the oversight of the Australian Securities and Investments Commission (ASIC) and removing any doubt that the consumer protection provisions of the ASIC Act apply to such policies.

This recommendation has no direct equivalent in New Zealand because funeral expense insurance policies are treated for regulatory purposes in the same manner as other life insurance policies. The sale of insurance policies to retail consumers is subject to compliance with the Financial Advisers Act 2008, the Fair Trading Act 1986 and the Consumer Guarantees Act 1993, as well as the fair dealing provisions in Part 2 of the FMCA.

However, as indicated by the Government following the release of the Life Insurer Report, the regulatory gaps identified by the FMA and RBNZ with regard to the conduct of life and general insurance business more generally will be addressed as a matter of priority, potentially by the end of 2019.

A deferred sales model for add-on insurance and a cap on commissions:

The Hayne Commission recommends that there should be an industry-wide deferred sales model for the sale of add-on insurance products and a cap on commissions that motor vehicle dealers can be paid for the sale of such insurance.

In New Zealand, extended warranties are excluded from the definition of “insurance contract” in the Insurance (Prudential Supervision) Act 2010 (IPSA)). The definition of insurance contract is one of the matters to be considered as part of RBNZ’s review of IPSA, which is currently on hold. Whether or not the sale of add-on insurance or extended warranties by motor vehicle dealers is regarded as problematic in New Zealand remains to be seen. However, the question of commission payments is likely to be addressed in New Zealand as part of a broader regulatory response to concerns around conflicted remuneration.

Pre-contractual disclosure and representations:

The Hayne Commission recommends that the Australian Insurance Contracts Act be amended in relation to consumer insurance contracts by replacing the duty of disclosure with a duty to take reasonable care not to make a misrepresentation to an insurer, and such that an insurer may only avoid a contract of life insurance on the basis of non-disclosure or misrepresentation if it can show it would not have entered into that contract on any terms.

The New Zealand Government has long signalled that the duty of disclosure, is not well understood by consumers and places consumers at unfair risk should they innocently fail to disclose relevant information to the insurer at policy inception or renewal. The duty of disclosure is one of a number of insurance contract law issues being considered by the Ministry of Business, Innovation and Employment (MBIE) in its review of insurance contract law. The recommendations of the Hayne Commission on this issue are therefore likely to be considered by MBIE when developing government policy to address this issue.

Unfair contract terms:

The Hayne Commission recommends that the unfair contract terms set outin the ASIC Act should apply to insurance contracts and that the duty of utmost good faith set out in the Insurance Contracts Act should operate independentlyof the unfair contract terms provisions.

MBIE is also considering, as part of the review of insurance contract law, whether insurance contracts should be made fully subject to the unfair contract terms provisions of the Fair Trading Act. It seems likely that the views of the Hayne Commission will also be taken into account in any final recommendations made by MBIE on this issue.

Claims handling:

The Hayne Commission recommends that the handling and settlement of insurance claims should not be excluded from the definition of “financial service”.

This recommendation should not have any repercussions for New Zealand insurance business, because claims handling would be viewed as part of the financial service of “acting as an insurer” for the purposes of section 5(1)(m) of the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (FSP Act). There is no equivalent exclusion of claims handling
from the definition of ‘financial service’ in that Act.

Status of industry codes:

The Hayne Commission recommends that the law be amended to provide for mandatory and enforceable industry codes. The Australian Life Insurance Code of Practice and the Australian General Insurance Code of Practice should be amended to empower the Life Code Compliance Committee or the Code Governance Committee to impose sanctions for breach of the applicable code.

This recommendation could be one that the Government will look at either as part of the insurance contract law review or the fast-tracked legislation proposed to close the regulatory gaps identified in the Life Insurer Report. The Insurance Council of New Zealand’s Fair Insurance Code (applying to member organisations’ general insurance business) and the recently adopted Code of Conduct for members of the Financial Services Council (which includes 95% of New Zealand life insurers) both include sanctions for serious breach of the relevant Code by a member, including fines of up to $100,000. It remains to be seen, however, whether the Government would seek to make compliance with these codes (or variants of them) mandatory for all industry participants.

External dispute resolution:

The Hayne Commission recommends that the law be amended to require Australian Financial Services licence holders to take reasonable steps to co-operate with the Australian Financial Complaints Authority in its resolution of disputes, including making available all relevant document and records.

This recommendation is unlikely to have any impact in New Zealand because the FSP Act already requires registered financial service providers to be members of approved external dispute resolution schemes. The rules of those schemes would require that all relevant documents and records relating to disputes be provided.

BEAR (Banking Executive Accountability Regime):

The Hayne Commission recommends that over time, provisions modelled on the BEAR be extended to all APRA-regulated insurers. (The BEAR, which came into force in 2018, is set out in Part IIAA of the Australian Banking Act and establishes accountability obligations for authorised deposit-taking institutions (ADIs) and their senior executives and directors. It also establishes deferred remuneration,
key personnel and notification obligations for ADIs).

In the banking sector, an existing concern of the CEOs of New Zealand subsidiaries of Australian banks is that they may be an “accountable person” under BEAR and have responsibilities under the Australian law for the CEO’s actions running the subsidiary. A key question, in times of stress, will be the compatibility of the CEO’s BEAR responsibilities with their NZ law responsibilities to act in the best interests of the subsidiary. When the BEAR is extended to cover Australian insurers, the CEOs of their NZ subsidiaries will have similar concerns.

We expect that the New Zealand Government will look closely at the principles underpinning the BEAR as a potential means to focus financial service firms’ boards and senior management on their responsibility for modelling good conduct and culture, and ultimately as a measure of performance against their performance indicators (which may require revising in the light of the FMA/RBNZ conduct and culture reviews). It also remains to be considered whether a New Zealand equivalent to the BEAR legislation is appropriate.

Group life policies:

The Hayne Commission recommends legislating universal key definitions and exclusions for default MySuper group life policies. It also recommends that the Australian Prudential Regulation Authority (APRA) should amend prudential standards to require RSE licensees (regulated superannuation funds and anapproved deposit funds) that engage related parties to provide group life insurance or who enter into arrangements with a life insurer giving the life insurer a priority or privilege in connection with the provision of lifeinsurance, to provide APRA with independent certification that the arrangements and policies entered into are in the best interests of members of the superannuation scheme. A recommendation is also made that APRA amend prudential standards to require RSE licensees to be satisfied that the status attributed to a member in connection with insurance is fair and reasonable.

These recommendations may be viewed as particular to the Australian market because it is common for Australian superannuation schemes to include a group life insurance benefit. Such arrangements exist in New Zealand superannuation schemes but they are not common. The more likely take-out for New Zealand insurers is the importance placed on certification that group insurance provided to customers of one entity by a related entity are in the best interests of those members. Such a certification would go beyond the concepts embedded in the FMCA in relation to related party dealings between managers of superannuation schemes and other managed funds and their related entities requiring certification that such dealings are on arms-length commercial terms.

Other key themes of the Final Report

Twin Peaks Regulation:

The Final Report reviews and recommends strengthening the existing “twin peaks” model of regulation, with APRA responsible for prudential supervision and ASIC for conduct supervision. One change recommended is a stronger focus by ASIC on using litigation as an enforcement tool over “soft enforcement” and use of enforceable undertakings.

The Hayne Commission findings highlight the lack of clarity in the New Zealand environment for supervision of conduct in insurance sector, with both the Commerce Commission and (to a lesser degree) the FMA having some responsibilities. New Zealand insurers (and banks) are not subject to conduct licencing. In our view it is likely that the NZ government will look at whether conduct licensing is appropriate for both life and general insurance and who should be the supervisor. The gaps in the regulation of insurers’ and intermediaries’ conduct was one of several issues highlighted in the IMF’s FSAP Report in 2017.

Changing culture and governance:

A consistent theme through the Final Report is the need for boards and senior management to set the necessary tone from the top. The Hayne Commission recommends that all financial services firms should, as often as reasonably possible, take proper steps to assess their culture and its governance; identify any problems with that culture and governance; deal with those problems; and determine whether the changes it has made have been effective. In addition, the Hayne Commission notes that boards cannot operate properly without having the right information. And boards do not operate effectively if they do not challenge management.

These themes are similar to the themes arising from the FMA/RBNZ reports into conduct and culture in the banking and life insurance industries, and must be a key focus for boards and senior management to address in the immediate term, and continue to monitor.

Financial Advice and conflicted remuneration:

The Hayne Commission makes a number of recommendations in relation to commission payments for financial advice, many of which are not directly relevant to New Zealand given that our financial advice regime differs from Australia’s, which has had capped commissions and grandfathering of conflicted remuneration provisions in place for some years.

However, a key take-out from the financial advice recommendations is the view that conflicts of interest and duty cannot be “managed”. Rather, they should not be permitted. This is most relevant with regard to commission based payments for insurance sales, with the Hayne Commission recommending that caps on commissions for life risk-insurance products should be reduced and ultimately set at zero, and all remaining conflicted remuneration exemptions should be reviewed with a view to banning them outright.

The fast-tracked legislation announced by the government following the release of the Life Insurer Report will likely seek to place some restrictions on commission payments, potentially following the Hayne Commission’s lead.

VIOS:

Despite criticism of the conflicts inherent in vertically integrated sales models, no recommendation has been made for such structures to change due to the cost and disruption that would follow. The Hayne Commission does however agree with the recommendation of the Australian Government Productivity Commission that the Australian Competition and Consumer Commission (the ACCC) ‘should undertake 5 yearly market studies on the effect of vertical and horizontal integration in the financial system’. The FMA and RBNZ have been critical of vertically integrated organisations in both their banking report and insurance report. We expect that both regulators will keep a watching brief of the ACCC’s market studies in this area.

Conclusion

The Final Report of the Hayne Commission, despite its stinging criticisms, is best embraced as a ‘once in a lifetime’ opportunity for Australian financial service providers to reset their moral compass and seek to regain customers’ trust. The same is true for the financial services industry in New Zealand, where customers’ trust is in a stronger position. By responding positively and proactively, the industry can avoid the worst of the difficult environment in which their Australian colleagues find themselves.

Footnotes

1 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, https://financialservices.royalcommission.gov.au/Pages/reports.aspx